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DBP 130-139

DBP 130-139

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7 N About these numbers

Who owes whom?
Here is one little area that sometimes causes confusion. You are no doubt familiar with the terms debit and credit. It helps to remember that the words are derived from debt (in this case an amount owed to you), and creditors (people to whom you owe money). Your accountant treats them as follows.
N Asset accounts have debit balances. If you extend credit to a customer you

debit accounts receivable for that customer (indicating that the money is owed to you); similarly – but perhaps stretching the concept – if you buy a clump press you debit machinery. The machine owes you money.
N Liability accounts have credit balances. If you borrow money you credit, say,

short-term loans from the bank (that is, the bank is your creditor).
N Expense accounts have debit balances. This is easy. When you pay out money,

you debit the expense account. When you pay office rent, you debit office rents paid.

Fig. 7.3 When financial transactions count
Your year planner has the date of your August holiday marked, I would guess, against August. It would not be so helpful for work scheduling purposes if you marked it on the day that you decided on Jamaica, or when you paid the deposit. So it is with financial transactions. For analytical purpose, debits are matched against the related credits, and they are each matched to the appropriate period of activity. This is not necessarily the same as the date when money changes hands. One example should suffice. Suppose that:

you are producing a monthly expenditure plan; your office rent is $1000 a month; and N you pay it once every three months in advance. For example, on 28 June you pay the $3000 that relates to calendar months July, August and September. The accounting entries are shown on the right. 1 In June, you credit (reduce) your bank balance by $3000 and debit (increase) the asset account prepaid rents by the same amount. 2 In each of July, August and September, you debit (increase) office rental payments by $1000 and credit (reduce) prepaid rents by the same amount. If the only other transaction is a 10 000 share issue in May, the transactions that show in your financial statements are as follows. Note the way that a change in the balance sheet between two dates (e.g., the change in prepaid rents between the end of June and the end of July) equates to a flow in the intervening period (P&L account – rents paid in July). This is examined in more detail in Chapter 9.


current year Total Profit & loss account Whole month Office rental payments Net profit (loss) Cash flow Whole month Share issue Office rental payments Total for month Net cash balance 10 000 0 10 000 Jun Jul Aug Sep 7 000 3 000 10 000 7 000 2 000 9 000 7 000 1 000 8 000 7 000 0 7 000 10 000 0 10 000 10 000 0 10 000 10 000 (1 000) 9 000 10 000 (2 000) 8 000 10 000 (3 000) 7 000 0 0 0 0 1 000 (1 000) 1 000 (1 000) 1 000 (1 000) The changes in the balance sheet are flows in the other accounts 1 0000 0 1 0000 1 0000 0 –3 000 –3 000 7 000 0 0 0 7 000 0 0 0 7 000 0 0 0 7 000 131 . customer deposits are liabilities with credit balances and loans to customers are assets with debit balances. Thus. in your company accounts you show a credit to the bank – the bank owes you less.The way that bean counters think The area of confusion is that when you take money out of your bank deposit account. When you show an increase in your bank deposit you show a debit entry – the bank owes you more. This is because you are then looking at it from the bank’s perspective. It is straightforward if you look at it from the view point of who owes money to the business. if you are drawing up a business plan for a bank. This is the exact opposite of what we normally say. When you go into your bank to put money into your account you fill in a credit slip not a debit slip. When you put money on deposit you become one of the bank’s creditors. May Balance Sheet End month Assets Cash at bank Prepaid rents Total Liabilities and shareholders’ equity Paid up share capital Profit (loss).

7 N About these numbers The planning horizon The planning horizon is the most distant point in the future that you will visit in the plan. “If the profits are great. the planning horizon will already have been staked out – probably three or five years hence.” Chinese proverb 132 . if you have monthly figures for the first year and annual figures for the remaining term. the budget is saying if our assumptions about our operating environment are correct this is how much we will spend and receive. By the time you start work on the financials. are no more than profit and loss and cash flow forecasts by another name (usually monthly). and N a set of financial targets. the production department could operate on a flexible budget. Sometimes it does not make sense to operate within a fixed budget. They show the end-period balances. the risks are great. Forecasts and budgets A budget is a misleading name for a set of financial projections or forecasts that have been formalized as: N an operating plan. when sales are very unpredictable. and quarterly or maybe only annual numbers for the remaining years. If you happen to be working on a plan covering longer than this. N for a given period of time – usually one year. The figures for the month ending 31 December are the figures for the end of the fourth quarter and for the end of the whole year. If you have mixed periods. Do not add balance sheet figures. Budgets. For example. include a summary for the early part of the plan for ease of comparison. you probably will not want to attach much credibility to forecasts more that five years out. For example. The sum of the expenditure figures for the 12 months January to December gives you total spending for the calendar year. show annual figures for the first year also. Essentially. Good business plans usually contain monthly figures for the first year. The budget is the forecast that you adopt as representing your best guess at the future. You can add together financial flows. The production manager might be authorized to increase spending by $100 000 for every extra 10 000 units of production above a pre-agreed volume. It is preferable to think of a budget as an operational financial plan – not as a budget that must be spent. used for planning and measuring performance.

If FIG 7. They always begin on the same shopping day. Remember that all the accounts show flows over time. the relationships will become evident as you work through Chapters 7–10 of this book. Capital outlays Fixed assets at cost – Depreciation = Net fixed assets Balance sheet Assets Cash flow Net profit – Fixed assets + Depreciation + Paid not expensed + Sales on credit – Expensed not paid = Net cash flow Fixed assets at cost – Depreciation = Net fixed assets Inventory Prepayments.The planning horizon How long is a month? To save me having to use complicated phrases. Some businesses – such as retailers – use a fourweek accounting period to help compare like with like.4 you are in doubt. and collect cash from the lucky buyer. 7. Perhaps it looks a little complex. the changes in balance sheet between two dates reveal flows. except the balance sheet. Accounts receivable Sales Sales Change in inventory Materials consumed + Depreciation + Production costs = Cost of sales Cash at bank Liabilities Accounts payable Accrued expenses Loans Owners' equity Capital Retained earnings Operating costs Employee costs + Depreciation + Other expenses = Total op. I tend to use the term year to mean the longer of a year or an operating cycle – the amount of time that it takes to buy stuff. costs Profit and loss Sales Less cost of sales = Gross profit – Operating costs = Net profit 133 . etc. but it is actually quite simple. turn it into a product. please interpret references to months as your shortest accounting period. which shows balances at a point in time.4 Financial relationships exposed This diagram shows the interrelationships between the three sets of transactions and the three financial statements. Also. As discussed in the text. Most businesses use a 12-month period Fig.

“Consider the past and you will know the future. your financial statements will look a little different. A $10 000 increase in net fixed assets could conceal a $15 000 acquisition and $5000 of depreciation. Don’t try it. It is the same for historical periods and forecasts. When and how you use the data that you extract is also discussed below. A decision to write-off a long-standing bad debt might suggest a reduction in assets when actually nothing fundamental has changed. If you are starting a new business and you want to spoil your accountant’s new year’s eve celebrations. try to make sure that the numbers are presented consistently. even if you are not in it for the money Much of the discussion here might appear to focus on the financials for business. t It’s the same. If you are involved with non-profit organizations. Looking back There is little need to dwell on how you find the historical figures that you need for your business plan. You just extract them from your records. I will expand on them in the following pages. when moving through history to the current figures and on to forecasts. government agencies or similar bodies.7 N About these numbers – fiscal year – that sometimes coincides with the calendar year. The only warnings to consider are that sometimes: N Summarized figures hide things. The figures that you need were introduced in Chapter 4. I am sure that you would never attempt to hide. perhaps coinciding with the tax year. Where a change in accounting policies causes lumpiness in the numbers. an increase in spending in reclassified or summarized figures. N Policy decisions and changes in practices mislead. It might run for some other period that is convenient for you. Professional number crunchers are good at spotting this. However. choose a fiscal year that matches the calendar year. say. In other words. in this case you will almost certainly have or be able to obtain historical examples that you can mimic in your business plan – and the broad principles are exactly the same as those discussed here.” Chinese proverb 134 . include an additional line that shows the earlier figures presented on the same basis as the forecast and explain what is going on.

) to arrive at gross profit. It builds on the market analysis that you have already done. Filling in gaps in the figures for the current year is more a matter of estimation than forecasting. It may be that when you see the bottom line you will need to work back through the Six steps to painless financial forecasts 1 Project sales revenue. Cash flow projections reveal your funding requirements – or cash surplus. you need to treat these slightly differently from other operating costs by spreading the outlays over their assumed operating life. 2 Identify the capital spending required. To avoid making frequent revisions to the forecast. try not to make it arithmetically dependent on the figures that you are forced to estimate and are likely to change. 5 Draw up a balance sheet (another largely mechanical step). 6 Check your cash flow requirements (also a mechanical restatement of the foregoing numbers). Multiply these by price to convert them into the value of gross sales revenue. This is the most important step.Crystal ball gazing Estimating the present I have mentioned already that you often find yourself preparing forecasts for next year when this year is not yet over. The second three are mechanical. 3 Work through the remaining operating costs. Crystal ball gazing There are six steps to painlessly producing successful forecasts. payments to suppliers. etc. The first three steps require varying degrees of thought. A $30 000 machine with a three-year life ‘costs’ you $10 000 a year. As discussed. “The trouble with facts is that there are so many of them. You can firm up on these as the planning exercise progresses. 4 Derive a profit and loss (income) statement – a simple mechanical exercise using basic arithmetic on the results of the first three steps. You will have a reasonable idea of the transactions yet to be recorded in the accounts. Then deduct the cost of those sales (raw materials. listed below. You should forecast sales volumes (quantities). It is all much more straightforward than it might appear at first glance. such as sales executives’ salaries and telecommunications costs.” Samuel McChord Crothers 135 .

136 . What if your competitor introduces a superior product at half the price? What if there is an economic disaster? What if it takes you twice as long to fix the bugs in the new software? If you want to make it sound deep and meaningful. This will show you the amount of funding that you would need if a doomsday scenario plays out. the second and subsequent forecasts are the result of common sense whatif analysis. because it shows that you have thought about all eventualities. You should start out by adopting the policy that you will amend the sales projections only if you first change the sales and marketing strategy and/or plan. We will return to this in Chapter 11. If you make one or two assumptions about your business there is a neat way to show the degree of confidence that you attach to various outcomes. It is a very important part of your business plan. Sometimes even most-likely and worst-case forecasts are not enough. Your readers probably do expect them. It may be that you want to produce a bestcase as well to please the boss. you can refer to what-if using the term sensitivity analysis. The most dangerous thing you can do if the funding requirement is too large is cheat by adjusting the revenue forecast on the basis that you probably underestimated sales in the first place.7 N About these numbers numbers to bring the funding requirement into line with reality – or to put the surplus to good use. You might not think that these extremes will happen. This is also discussed in Chapter 11. Most business people – and all solid business plans – require at least a second pass through the forecasting exercise to produce a worst-case projection. What if …? Producing a single financial forecast is not the end of it. In fact. or to encourage an investor or banker to pour money into your business. This might involve revisiting the marketing strategy or some other part of the plan. You sometimes hear this referred to as ‘scenario planning’.

For example. These give you worksheets – tables with blank cells. Maybe 20 other people have seen it and rejected it already? Business plans date rapidly – and when they do. This is especially true of plans for new projects or business start-ups. It might take longer to raise capital. t Which is the first month? Overheard in a corporate finance department: Look at the age of this business plan. It is enough to know how to: N format a cell so that the layout is pleasing. operating costs. one for each of sales. The extracts from sample business plans shown here (for example. you might think that a July launch date is entirely feasible. in the detailed financial projections. It’s still not funded. month 3. Spreadsheet techniques You should set up a workbook that essentially contains six tables. the balance sheet and cash flow. N enter simple formulas that add. When you start to write the plan in January. If you can use the facility to draw charts you are in a strong position. Make sure that you never enter the same information more than once. explain the basic principles and guide you through the groundwork. You might also decide to include worksheets for any additional tables that you produce in pursuit of your analysis and forecasts. 1 Minimize data entry. It shows that the project should have started two months ago. say. if you key in the months across the top of one spreadsheet. you are certain to have a colleague. the three financial statements on one page. In my experience. new ventures nearly always start later than expected. Corporate bosses and capital providers are rarely so accommodating. 8. see Fig. If you are not familiar with spreadsheets. ensure that all other instances of the dates pick up the values from 137 .9) use month 1. To avoid having to revise and reprint business plans. or perhaps you underestimated the amount of time required for cutting through all the red tape. into which you type information – that collect together into workbooks. month 2. such as MS Excel or Lotus 1-2-3. multiply or simply repeat other values. profit and loss. consider replacing dates with numbers. These can be six separate worksheets – or you could combine. or boxes. etc. friend or relative who loves their computer and will be only too pleased to set this up for you. These plans will never look out of date. they convey a bad impression. maybe other activities cause delays. If not you might consider a training course or evening classes.Software tools Software tools The way to tame your numbers and keep it under control is to use a computer spreadsheet. You do not need to be a spreadsheet wizard. capital outlays. Here are four useful tips.

7.7 N About these numbers the first row. 2 Automate. Jan-2001) into cell one.02 … ='SUNDRY'!E45 =SUM(E4:E28) =E3+1 =E4 … =E9*1. The same goes for numerical amounts such as number of employees or spending on salaries.. if you change the coverage period of the financial statements. the next eleven cells could be set as formulas Fig. if you key a monthyear (e. For example.02 … ='SUNDRY'!D45 =SUM(D4:D28) =D3+1 =D4 … =D9*1. Try to automate data entry further.5 Spreadsheet magic What you entered: A 1 2 3 4 … 14 … 28 29 30 31 32 33 34 35 36 Operating costs Year Salaries … Telecomms … Sundry costs Total expenditure B Only three new figures C D E F 1999 10 000 … 1 000 … =’SUNDRY’!B45 =SUM(B4:B28) =B3+1 =B4 … =B9*1.02 … ='SUNDRY'!F45 =SUM(F4:F28) =A3 =’GROSS’!A99 Less expenditure Net profit =B3 ='GROSS’!B99 =B29 =B33-B34 =C3 ='GROSS'!C99 =C29 =C33-C34 =D3 ='GROSS'!D99 =D29 =D33-D34 =E3 ='GROSS'!E99 =E29 =E33-E34 =F3 ='GROSS'!F99 =F29 =F33-F34 What you see: A 1 2 3 4 … 14 … 28 29 30 31 32 33 34 35 36 Operating costs Year Salaries … Telecomms … Sundry costs Total expenditure P&L summary Year Gross profit Less expenditure Net profit B C D E F 1999 10 000 … 1 000 … 143 23 967 2000 10 000 … 1 020 … 453 25 333 2001 10 000 … 1 040 … 122 24 666 2002 10 000 … 1 061 … 36 24 921 2003 10 000 … 1 082 … 445 24 921 1999 45 654 23 967 21 687 2000 34 566 25 333 9 233 2001 37 543 24 666 12 877 2002 35 567 24 921 10 546 2003 35 468 24 921 10 547 What it means: A 1 2 3 4 … 14 … 28 29 30 31 32 33 34 35 36 Operating costs Year Salaries … Telecomms … Sundry costs Total expenditure P&L summary Year Gross profit Less expenditure Net profit B C D E F 1999 Each cell displays the value in the cell to its left incremented by 1 10 000 Each cell displays the value from the cell to its left … … 1 000 Each cell displays the value in the cell to its left increased by 2% … … Each cell displays the corresponding value from the worksheet called 'Sundry' Each cell displays the sum of the values above Each cell displays the corresponding value from row 3 Each cell displays the corresponding value from row 29 Each cell displays the corresponding value from the worksheet called 'Gross' (profit) Each cell displays the value in row 33 less the value in row 34 138 . Then.02 … ='SUNDRY'!C45 =SUM(C4:C28) =C3+1 =C4 … =C9*1.g. you only have to make one amendment and the changes will ripple through all the spreadsheet.

you can give copies to R&D. Putting it to good use This introduction to accountancy’s idiosyncrasies. and so on for them to complete during the planning exercise. Changing the value in the first cell will cause all 12 months to be updated automatically. 139 . This is a sensible approach. the current-year profit (loss) in the balance sheet should be taken directly from the bottom line on the profit and loss account (which is calculated as the sum of individual entries). Make sure that you have understood the concepts raised in this chapter. When you are. put a formula in the second cell that displays 110% of the first cell. Again. 3 Carry forward totals. To ensure a painless interaction between the worksheets. When you have a standard workbook. you can use an additional identical workbook to automatically aggregate the numbers for the constituent departments. description. t Squeeze it in A venture capital provider I knew generally asked for detailed financials for the first six months only. and for broad expectations thereafter. When you get these workbooks back. blue). If you project that rent will rise in period two. It’s a good idea to use one colour to display the characters in the cells into which you key raw data (say. Marketing. You can always turn it sideways or spread over two pages. 4 Use colour. twelve months and a total) on one sheet of A4 or letter paper. use formulas to carry forward totals. You can then see at a glance which is which. In fact. But I usually print the final version in black only – to avoid distracting other users.Putting it to good use that calculate the value of the previous cell plus one month. the same applies to numerical data. I take this a stage further and use red print for cells which are mechanical projections so that it is easy to see where the assumptions are that might be modified during a review process. He maintained there are so many variables for a start-up that it is pointless trying to look further ahead. including tracking actual spending against budget. For example. I can’t wait. you will find that it is usually possible to squeeze in 15 columns (line number. But where you have to show more than six months for a financial statement or forecast. crystal ball gazing and spreadsheets should have set you in good stead for the rewarding task of working out your financial prospects. The workbooks can also be used for operational purposes. which is discussed in Chapter 13. You then have consistent financial plans for the whole business and its constituent parts. black) and another colour for all automated cells (say. see you in Chapter 8.

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